Private Equity Funds Massacred on London Stock Exchange

How does buying a private equity fund at a massive 80% discount to net asset value sound?

 

Prior to August 2007, private equity could do no wrong. Highly leveraged and active in mergers and acquisitions amid an environment of cheap credit since 2002, the sector enjoyed some of the most impressive margins. Most of those gains were predicated on leverage and cheap financing – two important market variables that no longer exist as the global credit crunch heads into its 19^th month.

 

It’s hard to make a bullish case for private equity at this stage of the economic cycle. Leverage has ceased, mergers and acquisitions are dead and the worst global recession since the early 1970s has tightened credit for most private equity companies, further crimping deal-flow.

 

Worse, U.S. and U.K. banks, which were aggressive lenders to private equity funds before the credit crises are now under government pressure to redirect loans to consumers and businesses

 

The sector is now in the midst of its biggest job redundancies in history with private equity companies in New York and London issuing pink slips virtually every week.

 

The most celebrated private equity firm, Blackstone Group (NYSE-BX), went public in the summer of 2007 just ahead of the sub-prime crash. The stock, which was also purchased by China’s leading sovereign wealth fund, has since collapsed a cumulative 77.6% leaving investors with very little to show for their original investment.

 

Of course, Blackstone’s boss, Stephen Schwarzman, scored billions in the company’s IPO or initial public offering in June 2007.

 

In London, home to hundreds of closed-end funds known as investment trusts, the entire sector has been almost demolished over the last 18 months. The Scottish invented the first collective investment trust back in the late 19^th century; their version was copied by the United States and reintroduced on the NYSE as closed-end funds in the early 20^th century.

 

As a group, private equity funds in London, which trade in depressed sterling, now average a discount to net asset value of almost 80%. This means investors can purchase a pound’s worth of private equity for just 20 pence on the pound – a pretty staggering discount.

 

Yet in order for these huge discounts to narrow, private equity funds must start allocating their capital to the numerous busted deals amid the market wreck. These vultures will struggle because cash-flow is not abundant and banks are reluctant to lend. If private equity can’t leverage-up their deals then your return on equity in these aggressive funds will be marginalized.

 

Still, London’s private equity investment trusts are worth watching. At some point the global bear market will end and the pound will stop crashing. When that happens, private equity will make a big comeback.